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Chapter 08: Sources of Short-Term Financing
8-24. (Continued)
e.
$6,850 360
Effective interest rate = $375,000 $75,000 60
$6,850 6 2.28% 6
$300,000
16.8%
−
= =
=
25. Bank loan to take cash discount (LO1 & 2) Harper Engine Company needs $600,000 to
take a cash discount of 1.5/10, net 60. A banker will loan the money for 50 days at an
interest cost of $12,100.
a. What is the effective rate on the bank loan?
b. How much would it cost (in percentage terms) if Harper did not take the cash
discount, but paid the bill in 60 days instead of 10 days?
c. Should Harper borrow the money to take the discount?
d. If another banker requires a 10 percent compensating balance, how much must
Harper borrow to end up with $600,000?
e. What would be the effective interest rate in part d if the interest charge for 50 days
were $8,300? Should Harper borrow with the 10 percent compensating balance?
(There are no funds to count against the compensating balance requirement.)
Chapter 08: Sources of Short-Term Financing
8-25. Solution: Harper Engine Company
a.
$12,100 360
Effective rate of interest = 600,000 50
2.02% 7.2 14.54%
= =
b.
( )
1.5% 360
Cost of lost discount = 98.5% 60 10
360
1.52% 50
1.52% 7.2 10.94%
−
=
= =
d.
( ) ( )
Amount
$600,000 $600,000 $600,000 $666,667 needed to be
1 C 1 .10 .90 borrowed
===
−−
e.
$8,300 360
Effective interest rate =$666,667 66,667 50
$8,300 7.2
$600,000
1.38% 7.2 9.94%
−
= =
= =
Chapter 08: Sources of Short-Term Financing
26. Competing terms from banks (LO2) Summit Record Company is negotiating with two
banks for a $100,000 loan. Fidelity Bank requires a 20 percent compensating balance, discounts
the loan, and wants to be paid back in four quarterly payments. Southwest Bank requires a 10
percent compensating balance, does not discount the loan, but wants to be paid back in 12
monthly installments. The stated rate for both banks is 9 percent. Compensating balances will be
subtracted from the $100,000 in determining the available funds in part a.
a. Which loan should Summit accept?
b. Recompute the effective cost of interest, assuming that Summit ordinarily maintains
$20,000 at each bank in deposits that will serve as compensating balances.
c. Does your choice of banks change if the assumption in part b is correct?
8-26. Solution: Summit Record Company
a. Fidelity Bank
( ) ( )
Effective interest rate
2 4 $9,000
= $100,000 $20,000 $9,000 4 1
$72,000 / $355,000 20.28%
− − +
==
Southwest Bank
( ) ( )
Effective interest rate
2 12 $9,000
=$100,000 $10,000 12 1
$216,000/$1,170,000 18.46%
− +
==
Chapter 08: Sources of Short-Term Financing
8-23
8-26. (Continued)
both banks.
Fidelity Bank
Effective interest rate= $72,000/($100,000 $9,000) 5
= $72,000/($455,000=15.82%
−
Southwest Bank
Effective interest rate = $216,000/($100,000 13)
= $216,000/$1,300,000 = 16.62%
will be less.
Chapter 08: Sources of Short-Term Financing
8-24
27. Accounts receivable financing (LO1) Charmin Paper Company sells to the 12 accounts
listed below.
Account
Receivable Balance
Outstanding
Average Age of
the Account over the
Last Year
A .................................
$ 60,000
28
B ..................................
120,000
43
C ..................................
70,000
10
D .................................
20,000
52
E ..................................
50,000
42
F ..................................
220,000
34
G .................................
30,000
16
H .................................
300,000
65
I ...................................
40,000
33
J ...................................
90,000
50
K .................................
210,000
14
L ..................................
60,000
35
Capital Financial Corporation will lend 90 percent against account balances that have
averaged 30 days or less; 80 percent for account balances between 31 and 40 days; and
70 percent for account balances between 41 and 45 days. Customers that take over
45 days to pay their bills are not considered acceptable accounts for a loan.
The current prime rate is 8.5 percent, and Capital charges 3.5 percent over prime to
Charmin as its annual loan rate.
a. Determine the maximum loan for which Charmin Paper Company could qualify.
b. Determine how much one month's interest expense would be on the loan balance
determined in part a.
8-27. Solution: Charmin Paper Company
a. 0-30 days Amount
A $ 60,000
C 70,000
Chapter 08: Sources of Short-Term Financing
8-25
31-40 days Amount
F $ 220,000
I 40,000
41-45 days Amount
B $120,000
E 50,000
b. Loan balances $ 708,000
Interest, 12% annual
Chapter 08: Sources of Short-Term Financing
8-26
28. Hedging to offset risk (LO5) The treasurer for Pittsburgh Iron Works wishes to use
financial futures to hedge her interest rate exposure. She will sell five Treasury futures
contracts at $107,000 per contract. It is July and the contracts must be closed out in
December of this year. Long-term interest rates are currently 7.3 percent. If they increase to
8.5 percent, assume the value of the contracts will go down by 10 percent. Also if interest
rates do increase by 1.2 percent, assume the firm will have additional interest expense on
its business loans and other commitments of $63,000. This expense, of course, will be
separate from the futures contracts.
a. What will be the profit or loss on the futures contract if interest rates go to 8.5 percent
by December when the contract is closed out?
b. Explain why a profit or loss took place on the futures contracts.
c. After considering the hedging in part a, what is the net cost to the firm of the
increased interest expense of $63,000? What percent of this $63,000 cost did the
treasurer effectively hedge away?
d. Indicate whether there would be a profit or loss on the futures contracts if interest
rates went down.
8-28. Solution: Pittsburgh Iron Works
a. Sales price, December Treasury bond contract
(Sale takes place in July) $107,000
Purchase price, December Treasury bond contract
c. Increased interest cost $63,000
Chapter 08: Sources of Short-Term Financing
8-27
Net Cost $9,500 15.08%
Increased interest cost $63,000
==
d. If interest rates went down, there would be a loss on the
